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Paul,

Why are you raising that very tired boogieman once again?
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Back in 2007, Kimberly Lanford, the contributing editor at Kiplinger, devoted a column to just such fears. Someone asked the following question: I've been reading about the financial troubles that E-Trade is having now and am concerned about my accounts. What happens to investors' accounts if their brokerage firm has financial trouble?

She replied as follows:
There are several safeguards in place to protect your money if your broker goes bust. Most important, brokers have to follow strict SEC rules about segregating the firm's money from the customers' investments. Even if the broker has financial trouble, the investors' money should still remain intact.

"Even if a firm is in very serious trouble, it can either merge with another brokerage firm or sell part of its business," says Stephen Harbeck, president and CEO of the Securities Investor Protection Corporation. "We only get involved when a firm used up its capital and has misappropriated customers' securities." SIPC has only been involved in six cases in the past four years.

Brokerage firms are members of SIPC, which protects investors when brokers go under and works a bit like the Federal Deposit Insurance Corporation (with some key differences). If a brokerage firm fails, SIPC first tries to transfer the investors' securities to another firm. If that doesn't work, then it tries to rebuild the investors' portfolios, even buying new stocks or bonds to make up for any missing shares.

"To the maximum extent practicable, we give you exactly what was in your account, and if we have to buy it we will," Harbeck says. If the investments aren't available, SIPC will give you cash based on their value when the brokerage went under.

Options are tricky, though. "We close out all options transactions on the date of the brokerage failure and either credit or debit the account as appropriate," Harbeck says. SIPC first returns your share of the broker's remaining assets, then uses its own funds (up to $500,000 per account, with a $100,000 limit on cash) to buy the same number of shares that you originally owned. That $500,000 limit only applies to the maximum amount SIPC will spend on its own to make up for any missing securities; not the total amount of money you can get back. If many of the customers' assets remain intact, you can get back a lot more than that SIPC limit.

But the downside is that you may lose access to your money for a while. "The fastest that an investor could conceivably get back in control of one's account is one week," Harbeck says. That happened during the MJK Clearing case in 2001, when the acquiring brokerage had the same computer system as the firm that went under. "In most situations, it takes two to three months," he says. And the process can stretch out even longer if the brokerage firm kept shoddy records.

SIPC does not protect against market losses while your account is in limbo. In the very rare cases in which an investor's losses exceed SIPC's limits, most brokers have supplemental insurance that kicks in to make up the difference. E-Trade, for example, has a total of $600 million in extra coverage, with a $150 million limit on the combined return to any customer from trustee distributions, SIPC and the extra coverage. SIPC covers cash and securities, such as stocks and bonds, held at a brokerage firm. Deposits at insured banks, such as E-Trade Bank, are covered by the FDIC. For more information about how the FDIC works -- and what happened to depositors when NetBank went under last month -- see my When a Bank Closes column. Also see the FDIC's Web site.
For more information about how SIPC works, and to make sure your brokerage firm is a member, see SIPC.org.

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The “bottom line” would seem to be this. If E*Trade doesn’t serve your investing needs, then don’t use them.

But if the over the years E*Trade has performed as well for you (or better) than any other broker, all of whom get attacked from time to time by stupid shareholders and vicious lawyers, why panic now? The assets held there are as safe as at any other broker, and any investor managing a sizable chunk of money is going to have at least a half dozen accounts anyway and/or be holding only a portion of his/her portfolio at E*Trade who does many things superbly well (as I asserted and stand by that claim) but not all of them.

http://www.kiplinger.com/columns/ask/archive/2007/q1115.htm
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